New disclosure rules for 401(k) fees go into effect next year

Aug 3rd 2010

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New regulations issued by the U.S. Department of Labor last month will force many 401(k) plan service providers to disclose fees that are deducted from a participating employee’s retirement account. Jason Bramwell reports.

Beginning July 16, 2011, service providers that are paid $1,000 or more from a retirement account must document the direct and indirect compensation they receive in connection with the services they provide.

Direct compensation is defined by the Department of Labor as compensation received directly from the 401(k) plan; indirect compensation is received from any source other than the plan sponsor, the covered service provider, an affiliate, or subcontractor. A written description of the services rendered must be included. Adjustments to the fee structure have to be disclosed within 60 days from the date on which the service provider is informed of the changes.

With more than 50 million Americans relying on 401(k) plans to finance their retirements, hidden fees can make a big difference in a family’s retirement security, government officials said. The U.S. Government Accountability Office recently found that a 1-percentage-point difference in fees could cut retirement assets by nearly 20 percent.

"Improving disclosure will mean that plan fiduciaries can make more informed decisions about important plan services, the cost of the services, and the potential conflicts of interest that their service providers may have," Phyllis Borzi, assistant secretary for the Department of Labor Employee Benefits Security Administration, said in a prepared statement.

William Kring, CFP, chief compliance officer with Smyrna, GA-based Kring Financial Management, told AccountingWEB that the new regulations are good for plan sponsors, participants, and people servicing the industry.

"The Department of Labor realized that the 401(k) market has grown to an enormous size, but the rules and regulations of disclosures haven’t kept up with it," Kring said. "Most plans run poorly from a fiduciary standpoint. With these new rules and proper fiduciary assistance, retirement plans can improve their offerings for the ultimate benefit of plan participants."

Stace Hilbrant, managing director of Wilmette, IL-based 401(k) Advisors LLC, felt these long-awaited rule changes were driven by the recession and a renewed focus on returns and fees.

"The [Bernie] Madoff situation added to the scrutiny, and that got the ball rolling faster down the hill it was already rolling down," Hilbrant said.

Plan sponsors and plan participants "not always knowing who was getting paid what" might have been another factor in the Department of Labor changing the regulations, added Dean Huber, partner in charge of employee benefit practice at Kernutt Stokes Brandt & Co. LLP, in Eugene, OR.

"It doesn’t change the dollars coming out of a plan; it just makes it more transparent as to where those dollars are going," Huber said. "When a fund manager uses part of the management fee they collect from the fund’s assets to pay fees to brokers, record-keepers, or other plan service providers, it will be easier to follow the dollars.

"I think the new fee disclosures will be so complicated that most people won’t even try to understand them," he added. "They may help a service provider when they are competing for new business. [Service providers] also may be able to justify a higher fee for some plan service when compared to a competitor because they have a lower fee for some other service."

According to a U.S. News & World Report article, service providers will be required to spell out any money withdrawn from 401(k) accounts, such as sales charges, redemption fees, and surrender charges. Providers also must disclose the annual expense ratio and a description of other costs, such as wrap fees and record-keeping services. A 401(k) plan could be billed for the fees, or payment could be deducted directly from participant accounts or subtracted from investment returns, the article stated.

"Because all the fees will be out there in the open, it’ll make for a more level playing field and lower costs," Kring said.

For example, fees that mutual fund companies paid to brokers, such as 12b-1 fees and finder’s fees, will now be disclosed under the new regulations, Hilbrant added.

"These fees will be public information, and that leaves plan sponsors wide open to anyone’s scrutiny for paying fees, such as to a broker," Hilbrant told AccountingWEB. "The justification for the fees paid will have to be there. In prior years, no one had to disclose on publicly available documents, like the [Form] 5500, what a broker was receiving, so there was no fee justification to worry about."

Despite the new disclosure rules, Huber does not believe investment companies will be pressured to lower their fees.

"Someone has to pay for all of the 401(k) infrastructure that doesn’t apply to IRAs and brokerage accounts or things like Web access, 24-hour phone access, and education," he said. "While some of that is typically provided to brokerage account holders, the software programming to aggregate all related accounts in order to prepare the annual Form 5500 and perform the necessary nondiscrimination testing is a true additional cost."

Hilbrant added, "Most mutual fund companies and especially insurance companies have been hit hard by [the recession]. There may be some fee lowering, but these entities still need to stay in business and make a profit. The greatest impact [these regulations] will have will come in the eradication of inappropriately high commissions or finder’s fees where in the past no one cared. Commissions or service fees paid out to brokers or advisors will be lowered if the service model can’t justify the fees."

Department of Labor officials believe the new regulations will be significant for the economy, bringing in an estimated $153 million in nondiscounted costs the first year. Those costs are attributable to reviewing and analyzing the rules, conducting a compliance review to ensure that service providers comply with the regulations, and preparing any new disclosures required by the rules. Costs in the second and subsequent years are expected to fall to an estimated $37 million, according to the department.

The Department of Labor will accept comments from the public on the regulations until August 30. For more information on how to submit comments or to see the interim final ruling on fee disclosures for 401(k) plans, visit www.dol.gov/ebsa.